Underwater Mortgages Drop to 9 Million as Home Prices Rise: Report

Rising home prices are pulling more borrowers from underwater, reducing the probability of future defaults.

NEW YORK ( TheStreet) -- Rising home prices are helping pull more distressed borrowers from out of the water, according to the March Mortgage Monitor Report from Lender Processing Services(LPS).

The number of underwater borrowers -- those who owed more than their homes were worth -- fell 41% from a year earlier. In total, 9 million borrowers or 18% of active mortgages were underwater at the end of March.

In states such as Florida and Nevada, the share of underwater mortgages is 33% and 39% respectively, well above the national average. Still, even these states saw improvements in borrowers' equity in their mortgages.

The decline in underwater or negative equity mortgages is significant, because borrowers who owe more than their homes are worth tend to default at higher rates as they lose the economic incentive to continue paying their mortgage.

"There has always been a clear correlation between higher levels of negative equity and new problem loan rates," according to LPS Applied Analytics Senior Vice President Herb Blecher. "Looking at the March data, we see that borrowers with equity are actually outperforming the national average -- at 0.6 percent, this group is quite close to pre-crisis norms. The further underwater a borrower gets, the higher those problem rates rise. Borrowers with loan-to-value (LTV) ratios of just 100-110 percent are actually defaulting at more than twice the national average. For those 50 percent or more underwater, we see new problem rates of 4 percent."

Still, the overall decline in negative equity has helped lower the "new problem loan" rate -- seriously delinquent loans that were current six months earlier -- to less than 1% for the first time since March 2007, according to the report. The new problem loan rate is now 0.84% nationwide.

Most of the problem loans on bank balance sheets have actually been delinquent for a very long time. More recently issued mortgages are performing very well because they have been underwritten amid much tighter credit quality standards.

The report also found that foreclosure starts -- fresh foreclosure filings -- continued to decline across states, dropping 8.2% month over month, while foreclosure sales rose 10.1%.

Foreclosure sales excluding California rose 13% in the first quarter over the fourth quarter of 2012. California saw a 35% drop in foreclosure sales in the wake of its newly enacted Homeowner Bill of Rights, which essentially has slowed down the foreclosure process in the state.